July 25 (Bloomberg) -- Munich Re, the world's second-biggest reinsurer, dropped the most in five years in Frankfurt trading after posting a 48 percent decline in quarterly earnings and warning of ``substantial'' writedowns on stock investments.

Profit for the year will be less than Munich Re's earlier forecast, with second-quarter net income dropping to about 600 million euros ($942 million) from 1.16 billion euros a year ago, it said today in a statement. Munich Re declined 7.3 percent after it said ``turmoil in the capital markets'' reduced the value of investments.

The Bloomberg Europe 500 Insurance Index dropped the most in four months as Hannover Re, Germany's second-biggest reinsurer, also said falling investments will make profit targets ``difficult.'' Munich Re, with 7 percent of total assets in stock, may have more writedowns unless markets recover, Chief Financial Officer Joerg Schneider said. The Dow Jones Stoxx 600 Index of European shares is down 23 percent this year, the most since 2002.

``The turbulence on the capital markets took its toll on Munich Re,'' said Manfred Jakob, a Frankfurt-based analyst at SEB AG, who has a ``buy'' rating on the stock. ``Investors are very sensitive right now because they had hoped the financial crisis was over.''

Munich Re fell 8.55 euros, the most since May 2003, to 107.88 euros. The shares are down 19 percent this year, valuing the company at 22.3 billion euros. It is scheduled to report second- quarter results on Aug. 6.

Beaten Down

Hannover Re fell a record 21 percent before paring its decline. The stock declined 7.2 percent to 29.97 euros in Frankfurt. Swiss Reinsurance Co., the world's biggest reinsurer, dropped 3.9 percent at 65.95 Swiss francs.

Investors have beaten down European insurance stocks on concerns that falling stock and real estate prices will reduce earnings and limit their ability to pay claims, requiring them to raise additional capital.

Insurers get the lowest valuation of any industry in the Dow Jones Stoxx Index of 600 European stocks, with an average price- to-earnings ratio of 7.7, lower than 8.5 for banks and the European average of 13.

``Every reversal of guidance is being severely punished by the stock market,'' said Robert Mazzuoli, an analyst at Landesbank Baden-Wuerttemberg, who has a ``buy'' rating on Munich Re and a ``hold'' rating on Hannover Re. ``Investors have had their fingers burned by financial stocks, so they are more sensitive.''

Munich Re raised 4 billion euros in a share sale almost five years ago to boost reserves and its credit rating. A three-year slide in European stocks forced the company to report a 2003 loss of 434 million euros.

Better Capitalized

This year, no large European insurer has had to raise capital because they are better capitalized than U.S. insurers and banks worldwide, said Clotilde Basselier, a Paris-based fund manager at Natixis Asset Management. Banks and financial-services firms worldwide have raised $345 billion since the subprime mortgage collapse last year triggered the credit crunch.

Munich Re is unlikely to need more capital, said Konrad Becker, an analyst at Merck Finck & Co. in Munich who has a ``hold'' rating on the stock. ``While nothing can be ruled out in times like these, as of today Munich Re's capital resources are sufficient, and a capital increase won't be mandatory.''

Munich Re had 75.5 percent of its assets invested in loans and fixed-income securities and 2.8 percent of its investments in real estate at the end of the first quarter. Equity investments represented 7.2 percent after hedging with equity derivatives.

Hedging Gains

Gains of 1.13 billion euros from those hedging instruments helped offset impairment losses on equity investments of 1.33 billion euros in the first three months of the year due to price falls on the stock markets, Munich said in its quarterly report published in May.

Munich Re reported writedowns of 5 million euros on total subprime investments of 280 million euros in the first quarter. Writedowns of fixed-income securities ``were only small in scope,'' it said today.

The reinsurer said this year's profit will be ``well above 2 billion euros.'' That compares with an earlier forecast of profit excluding so-called minority interests of 3 billion euros to 3.4 billion euros.

Munich Re reiterated its target to increase per-share earnings by an average of 10 percent until 2010, helped by share buybacks. The company also repeated plans for an additional 5 billion euros in stock repurchases by 2010.

Credit-Default Swaps

Credit-default swaps on Munich Re rose 3.5 basis points to 50, according to CMA Datavision. A rise indicates deterioration in the perception of credit quality. A basis point on a credit- default swap contract protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year.

Munich Re's primary insurance unit Ergo Versicherungsgruppe also reduced its full-year profit outlook to between 320 million euros and 380 million euros, it said in a separate statement. That's down from a previous range of 480 million euros to 600 million euros. Half-year profit fell 33 percent to 269 million euros, the insurer said.

To contact the reporter on this story: Oliver Suess in Munich at osuess@bloomberg.net

Last Updated: July 25, 2008 12:43 EDT